Credit rating companies may soon be required to have independent directors forming the majority on their boards and include a nominee of the regulator.
Following the IL&FS default, Sebi plans to overhaul the governance structure of rating firms by revamping the composition of their boards and enhancing disclosure norms, seeking to address conflict of interest in business practices.
Other key proposals include barring shareholder-directors from being part of the compensation and audit committees of rating companies, said a person familiar with the development. Sebi is also considering a proposal that rating companies store client data and rating-related notes and documents locally to enable easier retrieval by probe authorities.
Sebi reviewed the corporate structure of rating firms and made some critical observations on the independence and objectivity of their boards and management.
“Recent investigations in the Infrastructure Leasing & Financial Services default revealed the apparent conflict of interest in the conduct of the business of credit rating companies in India. Such risks are often related to their corporate and compensation structure. Rating companies are important market intermediaries helping investors for better risk discovery in debt,” the person said.
The regulator is gathering feedback from rating companies before finalising its proposals.
There are seven credit rating companies registered with Sebi and accredited by the Reserve Bank of India as external credit assessment institutions in the country.
Sebi proposes to nominate a person on the board of each credit rating company for a period not exceeding three years.
The regulator may ask rating companies to have independent directors in a majority at all times. The maximum tenure for independent directors should not exceed three years and they can serve for not more than two terms, although not consecutively, said people familiar with the matter.
“None of the rating agencies has a majority of independent directors on their boards and in some cases, they (independent directors) are not there at all,” said another person familiar with the development.
It is proposed that rating companies would put in place a remuneration and compensation committee, where most of the members are independent. The committee will frame broad policies on the remuneration of employees designated as analysts who are directly involved in recommending or deciding the rating of an issuer. This could include the chief rating officer.
The remuneration policy framework may have to be published on the company’s website.
“De-linking an analyst’s compensation from the company’s profit will take the pressure off him,” said a senior official from a rating agency.
In the wake of the IL&FS crisis, rating companies may have to disclose the standalone ratings of subsidiaries, apart from the parent company’s ratings, disclose the rate card and provide a sectoral outlook, among other things. Currently, rating companies only provide a rating outlook and not a sectoral outlook. “Globally, rating agencies disclose the rate card,” said an official with a rating company.
Rating companies would have to disclose their whistleblower policy and create a transparent and anonymous system that’s available to the board and Sebi. “The board should form a committee to deal with any whistleblower complaints received as per approved policy and file a report after conducting due investigation with Sebi,” said one person.
Sebi may tighten norms for the outsourcing of activities related to the rating business. Some rating companies have been farming out key rating activities such as financial data input and interpretation, site visits and business development to associate companies or third parties.
The regulator observed that some rating companies maintain confidential data and rating-related notes and documents of clients on cloud servers.
“Such servers are usually located outside India and later retrieval of data and trail of the same by investigative authorities becomes a challenge. Hence, it is recommended that all data and related technology to be hosted in a location based out of India and appropriate disaster recovery mechanism to be built,” Sebi has proposed.
Source- Economic Times.